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The Only Bond Bear Worth Listening To

The U.S. Treasury itself is signaling higher rates ahead.

Many people believe that the bond market is the next bubble waiting to burst. If you're one of them, then you should keep your eyes on a recent phenomenon, because it could pave the way to falling bond prices and higher yields in the near future.

Actions speak louder than wordsWhen you're trying to put a reasonable value on something, one logical thing to do is to see how sellers are behaving. If they're selling more of one thing than another, then they must believe that they're getting a better deal on what they're selling than on what they're passing up.

Apply that principle to the bond market, and the obvious place to turn is to institutions that issue bonds. And the biggest issuer of all is the U.S. Treasury.

In recent months, Treasury Secretary Timothy Geithner has been taking steps to lengthen the average maturity of the Treasury's outstanding debt. After seeing the average maturity of its portfolio of debt fall to a 25-year low of just over four years, the Treasury announced plans to restructure its future borrowing to increase that figure to between six and seven years -- well above its historical average of five years, according to Bloomberg.

Going longAt first glance, the Treasury's actions make no sense. Short-term Treasuries yield almost no interest at all right now, while the rates on 30-year bonds are over 4.5%. With more than $12 trillion in debt, that 4.5 percentage points represents more than $500 billion a year in interest costs.

However, the Treasury's move indicates its belief in two things: First, that short-term interest rates have nowhere to go but up and will have to start rising at some point in the near future; and second, that by the time those short-term rates start to rise, long-term rates will already be significantly higher. Using the same logic that a homeowner uses when refinancing a mortgage, locking in those low fixed rates right now makes some sense, even if it means giving up what amounts to an artificially low promotional rate that will expire sooner than later.

The private sector agreesMoreover, the government isn't alone in taking advantage of extremely low long-term rates to refinance their debt. Just look at some of the companies that have issued intermediate- and long-term corporate bonds in the past year:

Stock

Amount of Bonds Issued

Term of Bonds

Morgan Stanley(NYSE:MS)

$4 billion

5 and 10 years

Microsoft(NASDAQ:MSFT)

$3.75 billion

5, 10, and 30 years

Pfizer(NYSE:PFE)

$13.5 billion

3, 6, 10, and 30 years

Caterpillar(NYSE:CAT)

$3 billion

3, 5, and 10 years

Boeing(NYSE:BA)

$1.85 billion

5, 10, and 30 years

Becton Dickinson(NYSE:BDX)

$750 million

10 and 30 years

Dow Chemical(NYSE:DOW)

$6 billion

5, 10, and 30 years

Source: Company releases.

In some cases, these companies didn't even really need to incur the debt in the first place. For instance, with a huge amount of cash already on its balance sheet, Microsoft might seem like an unlikely candidate to tap the capital markets by issuing bonds.

But investors should appreciate the long-term vision that these moves show. By thinking past the current economic environment to a time when it may be a lot harder to get financing, companies are banking credit while it's available cheaply and easily.

Should you buy?The question investors have to ask is whether they should buy what the Treasury and other bond issuers are selling. As I see it, if sellers think they're getting a good deal by issuing bonds at today's prices, then buyers need to be wary that they're getting a raw deal by paying too much for them. As a borrower, locking in a 30-year loan at 4.5% may sound attractive -- but from the other end of the deal, accepting that low a yield for that long a time leaves you exposed to all sorts of future risks.

If you're among the millions of investors who've flocked to long-term bonds in search of higher yields, you might want to think twice about your decision. The Treasury is clearly on the other side of that trade -- and fighting the Treasury might not be the best way to reap big profits from your investments.

Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
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